Legal and Ethical Duties of Lawyers after Sarbanes-Oxley

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Abstract
This article examines the legal and ethical duties of lawyers after the Sarbanes-Oxley Act, focusing in particular on the application, interpretation and ambiguities of the SEC rule governing lawyers implementing Section 307 of the Act. The SEC rule is discussed in the context of lawyers’ general ethical obligations as well as legal obligations under the securities laws. The article advances three major propositions. First, it argues that the SEC’s rule is largely consistent with and reflects the pre-existing ethical and legal duties of lawyers representing an entity client. The characterization of the SEC’s rule as a fundamental change in the relationship of a lawyer to a corporate client is wrong; the change is that the SEC’s rule might prove to be a more effective deterrent than state disciplinary agencies. Second, the reporting up obligation of the SEC’s rule serves as a useful reminder to corporate lawyers that their obligation is to the entity, not its management. However, a number of major loopholes in the SEC’s rule threaten to nullify the effectiveness of the reporting up requirement. Third, the reporting out obligation (noisy withdrawal) that the SEC considered but did not adopt, is a good idea that is consistent with lawyers’ extant legal obligations and ethical obligations in most states.
Electronic copy available at: http://ssrn.com/abstract=1524359
Legal and Ethical Duties of Lawyers after Sarbanes-Oxley
Roger C. Cramton, George M. Cohen & Susan P. Koniak
ABSTRACT
This article examines the legal and ethical duties of lawyers after the Sarbanes-Oxley Act,
focusing in particular on the application, interpretation and ambiguities of the SEC rule
governing lawyers implementing Section 307 of the Act. The SEC rule is discussed in the
context of lawyers’ general ethical obligations as well as legal obligations under the securities
laws. The article advances three major propositions. First, it argues that the SEC’s rule is largely
consistent with and reflects the pre-existing ethical and legal duties of lawyers representing an
entity client. The characterization of the SEC’s rule as a fundamental change in the relationship
of a lawyer to a corporate client is wrong; the change is that the SEC’s rule might prove to be a
more effective deterrent than state disciplinary agencies. Second, the reporting up obligation of
the SEC’s rule serves as a useful reminder to corporate lawyers that their obligation is to the
entity, not its management. However, a number of major loopholes in the SEC’s rule threaten to
nullify the effectiveness of the reporting up requirement. Third, the reporting out obligation
(noisy withdrawal) that the SEC considered but did not adopt, is a good idea that is consistent
with lawyers’ extant legal obligations and ethical obligations in most states.
Electronic copy available at: http://ssrn.com/abstract=1524359
-i-
LEGAL AND ETHICAL DUTIES OF LAWYERS
AFTER SARBANES-OXLEY
By
Roger C. Cramton, Cornell Law School
George M. Cohen, University of Virginia School of Law
Susan P. Koniak, Boston University School of Law
I. INTRODUCTION 1
A. Setting the Stage 1
B. A Situation to Ponder 5
II. REPORTING MATERIAL VIOLATIONS OF LAW UP THE CORPORATE
LADDER 9
A. Reporting Duties of a Corporation’s Lawyer Under State Law 9
B. Required Reporting under Section 307 of Sarbanes-Oxley 13
1. Which Lawyers Are “Appearing and Practicing” Before the SEC Under
Part 205? 13
a. Application of the SEC Rules to Lawyers Who Do Not Specialize in
Securities Law 14
b. Application of the SEC Rules to Lawyers Who Do Not Sign Docum
ents
Files
with
the
SEC
16
c. The Exclusion of Lawyers Not In a Lawyer-Client Relationship
with the Issuer 17
d. The Partial Inclusion of Foreign Lawyers 19
e. Law Firms as Legal Persons Who “Appear and Practice” 20
2. What Triggers the Lawyer’s Initial Duty to Report? 21
a. The troublesome double-negative standard 22
b. The ambiguity of “reasonably likely” 23
c. “Becomes aware” and the duty of inquiry 25
d. Imputed knowledge 29
e. Conclusion: The importance of the initial trigger 32
3. Obligations of the Reporting Lawyer after the Initial Report 32
a. The SEC’s Legitimate Concerns, and Their Proper Resolution 35
-ii-
b. The Mistaken Transplanting of Colorable Defense from the
Litigation Context to the Counseling Context 37
c. Other Problems with the SEC’s Third “Appropriate Response”
Option 39
4. Obligations of Other Lawyers After the Initial Report: The
Wrongheaded Exemptions for Advocates and Investigatory Lawyers 43
C. Reporting Up in the Spiegel Case 46
1. The Relevant Facts 46
2. Did Kirkland Perform Its “Up the Corporate Ladder” Report Obligations? 48
II. DISCLOSURE OF CONFIDENTIAL INFORMATION OUTSIDE THE
CORPORATION (“REPORTING OUT”) 49
A. Permissive Disclosure Under State Ethics Rules 49
1. Some Relevant History 49
2. Current State Law on Disclosure of Confidential Information and Related
Issues 51
3. Effect of Lawyer Disclosure of Confidential Information on the Client’s
Attorney-Client Privilege 53
B. Permissive Disclosure Under SEC Part 205 55
C. The Validity and Preemptive Effect of Permissive Disclosure Under Section
205.3(d)(2) 57
1. Validity of the SEC Permissive Disclosure Rule 58
2. The SEC’s Authority to Preempt State Law 60
3. The Irrelevance of Federalism Concerns 63
4. Does the Permissive Disclosure Rule Promulgated by the SEC in Fact
Preempt State Law? 65
5. The SEC and the State Bars Square Off 66
a. Round One: The Washington State Bar Interim Opinion 66
b. Round Two: The SEC Response 68
c. Round Three: The California Bar Committee’s Retort 69
d. Let’s Get Real 73
6. State Rules That Go Further Than Those of the SEC 74
D. Lawyer Conduct in the Spiegel Case: Withdrawal and Disclosure 74
1. Facts Reported by Spiegel’s Bankruptcy Examiner 74
2. Kirkland’s Failure to Withdraw, Disaffirm Filings, and Notify the SEC 76
3. Was White & Case Required to Withdraw, Disaffirm Documents, or Disclose
to the SEC? 79
IV. “NOISY WITHDRAWAL” 82
A. Required Withdrawal and Disaffirmance of Tainted Opinions Under State
Law 82
B. The SEC’s Noisy Withdrawal Proposal 83
1. The Original Proposal: Reporting Out by the Issuer’s Attorney 83
-iii-
2. The Alternative Proposal: Reporting Out by the Issuer 84
3. Which Form of Noisy Withdrawal Is Preferable? 86
C. Does Permissive Disclosure or Noisy Withdrawal Undermine
Confidentiality or Adversely Affect the Lawyer-Client Relationship? 87
D. The Spiegel Case Indicates Why the SEC Should Require Noisy Withdrawal 89
V. CONCLUSION 92
Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, §307, 116 Stat. 745, 784. Several other provisions of
1
the Act apply to lawyers but are not considered in this article. Section 602 codified part of Rule 102(e) of the
Commission’s Rules of Practice, establishing standards for disciplining professionals from practicing before the
SEC; section 806 provided “whistleblower” protection for employees of public companies in fraud-related matters;
and section 3(b) provided sanctions for violations of the Act or related rules.
Page 1
GMC draft – January 9, 2004 Rough Draft – Not for Publication or Quotation
LEGAL AND ETHICAL DUTIES OF LAWYERS
AFTER SARBANES-OXLEY
By
Roger C. Cramton, Cornell Law School
George M. Cohen, University of Virginia School of Law
Susan P. Koniak, Boston University School of Law
I. INTRODUCTION
A. Setting the Stage
In the first years of this new century a succession of massive corporate frauds dominated
the business sections and front pages of major newspapers, shaking public confidence in the
integrity of corporate America. Those scandals also raise serious questions about the integrity,
acuity and prudence of the accountants and lawyers who structure and document business
transactions, approve required financial disclosures, and, in the case of accountants, certify the
accuracy of required reports.
Congress responded by enacting the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”),
which became effective on July 30, 2002. Sarbanes-Oxley makes many changes in the securities
1
regulation process to improve corporate governance and reporting. It imposes harsh penalties on
violators, creates an elaborate system for governing and regulating auditors for public companies,
and requires the securities industry’s self-regulatory organizations to adopt rules to prevent
conflicts of interest and enhance the independence of securities analysts. Even casual observers
of the political reaction to the stunning disclosures about Enron, WorldCom and Tyco’s deceitful
financial practices might have predicted some such legislative response. But even careful
observers might well have been surprised by section 307 of Sarbanes-Oxley, directing the SEC to
promulate “minimum standards of professional conduct for attorneys appearing and practicing
before the SEC in any way in the representation of a issuers,” because so little public attention
  • Article
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    The Sarbanes Oxley Act of 2002; and more particularly, Section 307 creates a mandatory Chief Legal Officer (CLO) position within corporations practicing before the Securities and Exchange Commission (SEC). The new duties that have been imposed by the SEC, and which are now owed by corporate counsel, have presented ethical dilemmas and conflicting duties for in-house counsel for public companies. The CLO in a corporation now finds themselves functioning as a gatekeeper, or a watchdog for the government; and as such, these lawyers have a duty to report to the SEC certain conduct within the company they represent. However, lawyers also owe fiduciary duties to officers and directors, and to the corporation as a client. In these many, overlapping, and interwoven roles, corporate lawyers face great difficulty in complying with all aspects of both their professional and ethical duties. The attorney-client privileges in which the legal profession is so heavily grounded - such as confidentiality - are quickly eroding in the wake of Sarbanes-Oxley's new reporting requirements, and the lawyer’s ability to remain independent and objective has been fundamentally constrained. The "up-the-ladder" reporting requirements imposed on corporate counsel require upon a finding that there has been wrongdoing that the attorney report to the CLO or CEO, and if they do not respond adequately, counsel is then required to report to the board of directors, auditor, or other committee. Corporate counsel is traditionally hired by, and therefore loyal to, the CEO; and reporting up the ladder (and over the CEO’s head) can pose a difficult decision for the attorney, and in some cases, even conflict with a state’s code of professional conduct. And, in light of a substantial increase in SEC actions against lawyers, one must ask whether Sarbanes-Oxley provides workable guidelines, within which corporate counsel can perform their duties without fear of reprisal – either on the part of the SEC or their client.
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      Michael A. Perino
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